Timothy C. Voit, Financial Analyst
The division of pension benefits by way of Qualified Domestic Relations Order or QDRO is growing in popularity when it comes to divorce, and is nearly commonplace when 1) the lump-sum present value is too large to adequately offset the value of the pension against other assets of the marriage, or 2) when the parties to the divorce cannot agree as to the present value of the pension in question. A QDRO is a court order ordering a pension plan to award a portion of a participant's accrued pension benefits, or account balances, to a spouse, former spouse, or dependent pursuant to a divorce.
Not all retirement plans accept QDROs. Government plans, for example, are exempt from accepting QDROs, although nearly all state retirement systems, the federal government, and the military accept a form of domesic relations order. Many municipal pensons do not accept any type of court order to divide a pension as marital property. Income Deduction Orders (IDOs) are not QDROs and are generally used only for alimony or child support. Furthermore, on the issue of IDOs, the pension would have to be in-pay status to be effective. Therefore caution is advised when confronted with a municipal pension in divorce. Because a QDRO creates an obligation between the plan and former spouse (or spouse or dependent), such an obligation does not exist between those plans which do not accept QDROs. In this case it is advisable to value the pension and offset the former spouse's share. Since most plan participants of municipal pensions also participate in a deferred compensation plan (457 plan), an alternative would be to award as much as possible to the former spouse in lieu of 50% of the pension, for example.
Keep in mind, the contributions and employer funded benefits, is income that otherwise would have gone into the amily household, but instead was allocated to a retirement account or pension fund. If one spouse contributed to a savings account during the course of the marriage, most states would consider the account marital property. This is but one reason why Congress and each of the individual states consider pension as marital assets.
More and more pension plans are now offering model language of their own, or model orders specific to their plan where the attorney simply fills in the blanks. What is interesting is often times the model QDROs are drafted to conform to the domestic relations laws of the state the company is located in. It is worth mentioning that it is the state that determines who is entitled to what, not the plan. Therefore each state defines an alternate payee's share differently depending on what they consider marital. Clearly, the attorney should not simply "fill in the blanks", but rather gain an understanding of the options and benefits available not to mention in order to conform to the domestic relations laws of their state.
There is no question that many of the model orders provided by the pension plans themselves have a bias toward their own interest first, the employee/participant second, and lastly the non-participant spouse. While the participant spouse in a pension plan already has the benefits of the pension, it is the non-participant spouse's, or their attorney's, responsibility to make certain they request any and all benefits rightfully entitled to the alternate payee since the court often orders an equitable distribution. Regardless, the attorney should not feel that they are permitted only to use the model language offered by the plan nor be limited to the language offered by the IRS bulletin. Many of the models include language stating that the plan will not be held liable for any misinterpretations, etc. The attorney, therefore, is not "off the hook" in terms of liability simply because they choose to use a model order.
For every retirement plan that needs to be divided pursuant to a divorce, generally a separate QDRO is required. There are very few plan administrators that will allow you to address two or more plans with one QDRO. In addition, a court order to divide retirement benefits is not a QDRO until it is qualified by the plan, or the plan administrator. It is not qualified by the court. Until the order is qualified by the plan it remains a domestic relations order and unexecuted. With regard to marital settlement agreement language as it pertains to pension benefits, much confusion can be avoided, not to mention liability, if the issues are addressed before the divorce.
First and foremost, the attorney needs to determine what type of plan is being divided. Basically, there are two types of plans worth mentioning here. A plan that is expected to pay a monthly benefit at a certain retirement age is considered a defined benefit plan. That is, the monthly payment is derived primarily from the years of service and the average annual earnings of the participant. Generally, these plans are 100% employer funded where the employee does not make any contributions and no account balance exists.
A plan that defines a contribution to be made at present, i.e. percentage of earnings, leaves the future value of the benefits uncertain and is regarded as a defined contribution plan. Plans that have the terms "Savings Plan", "Retirement Savings Plan", "Incentive", "Profit Sharing" or "ESOP" in the plan name are considered defined contribution plans, where the account balance at any given time is the present value. The defined contribution plan generally has an individual account balance which is valued at least once each year on the "valuation date". Therefore, most defined contribution type QDRO's cannot divide an account balance as of the date of divorce, separation, or date of filing, but rather the "closest valuation date" to the date of division.
In some instances a participant may not be fully vested in the contributions made to the plan by their employer, however, the participant is always 100% vested in their own contributions. Nearly every state views retirement plans as marital assets regardless of vesting. In effect, vesting is a not an issue in divorce. If it is a concern, a QDRO can be drafted to zero-in on certain sub-accounts, such as employee contributions only.
Sometimes it is erroneously assumed that an immediate distribution can be made from a defined contribution plan since it has an account balance. This is not always true. Nor should the divorce be contingent upon an immediate distribution being made to an alternate payee unless it is known with certainty that, in fact, the plan will make such a distribution. There are times when the court, or the parties' judgment or settlement agreement, states that the plan is to make a distribution within a certain amount of time, say 30 days. Retirement plans, in the private sector, are governed under federal laws, therefore a local court cannot order a plan to make a distribution or provide any other benefit/distribution not otherwise provided by the plan.
Without delving too much into the statutory requirements, all QDRO's must include a designated alternate payee defined as spouse, former spouse, child or other dependent of the participant The order must specify other important information such as the amount or percentage of the participant's benefit which are to be paid to the alternate payee, the manner in which the amount is to be determined, and the period to which the order applies. The order must specify each plan to which the order applies, i.e. the specific name of the plan, along with the full names, last known mailing addresses of the participant and the alternate payee, social security numbers, dates of birth, and date of divorce or division.
There are generally two approaches to drafting a QDRO which, for the most part, apply to defined benefit plans. They are the Separate Interest Approach, or an independent interest, and a simple division with, or without, survivor benefits attached sometimes referred to as a "shared" interest.
A Separate Interest Approach adjusts the amount awarded to be paid over the lifetime of the alternate payee rather than the participant's lifetime. This is often referred to as "actuarially equivalent" language. That is, the awarded benefit will be converted to a payment based on the age and gender of the alternate payee as opposed to that of the participant. Keep in mind, that some defined benefit plans will not afford an independent interest to an alternate payee.
Primarily with defined benefit plans, the benefit itself may be divided, or awarded, in terms of a percentage, a flat dollar amount, or by a fractional method. Each method of division will result in distinctly different amounts being awarded. Consideration should be given to either fixing the benefit as of the date of divorce or pro-rating the final retirement benefit by way of the fractional method that may allow for some growth in the alternate payee's share.
In addition, under a QDRO, the alternate payee can commence benefits at the participant's earliest retirement age, regardless of whether it is a defined contribution plan or a defined benefit plan and regardless of whether or not the participant retires. Under a defined benefit plan, the normal retirement benefit will be reduced to reflect the earlier commencement of benefits. This is not possible with governmental plans. Under a court order dividing retirement benefits, other than a QDRO, the alternate payee must wait until the participant commences their retirement benefits. The participant controls under these circumstances.
Upon the death of the alternate payee, benefits cease and are generally forfeited to the plan, unless otherwise specified in the QDRO. This means that the benefits otherwise payable to the alternate payee can be made to revert to the participant or to "contingent" alternate payees, although the latter is not very common provision. The terms and conditions of the plan prevail in terms of what is allowed in a QDRO. With some plans, it is possible to name the children of the marriage as contingent alternate payees. However, certain restrictions apply when naming a dependent as an alternate payee, other than a former spouse, specifically in terms of how long the benefit is paid to them. In addition, some plans will not allow for the benefit to revert to a participant should an independent interest be granted to the alternate payee.
Other issues to consider include awarding the alternate payee any possible subsidized benefits, cost-of-living-adjustments and/or post-retirement increases. Subsidized benefits are usually in the form of early retirement incentives or enhancements to the monthly benefit to encourage early retirement. If not mentioned in the QDRO, the alternate payee will not receive these benefits and therefore the result may not be an equitable distribution. The same is true for cost-of-living-adjustments or post-retirement increases. If not mentioned, they too may not be awarded to the alternate payee. Traditionally, the lump-sum present value of a participant's benefits should be determined first to give both parties an idea of what this asset is worth. Although subjective, a relatively accurate present value can be determined based on the facts of the case and a few assumptions using reliable statistics. Unfortunately, the appropriate methods for valuing pensions, or appropriate methods for extracting the marital portion, cannot be fully explored in this article.
Tim Voit is a Financial Analyst and Managing Partner of Voit Econometrics Group, Inc. Tim Voit has been involved in researching pension plans for valuation or QDRO purposes in addition to assisting law firms in dividing retirement benefits on private, military, and governmental plans. Tim Voit is also a court admitted expert on pension related issues along with being retained as an expert in malpractice cases on behalf of the insured to analyze and "fix" poorly drafted QDRO's. A sample questionnaire/authorization directed to pension plans, asking many of the questions addressed here, can be obtained by contacting Voit Econometrics Group, Inc. at